macro: Hayek vs Keynes Still Matters

Robert Skidelsky wrote in the Financial Timesthat recent debates among economists are a rerun of the disagreements between John Maynard Keynes and the U.K. Treasury in the early 1930s. To a certain extent this is true. But it might be more instructive to pay some attention to another debate in the 1930s. This is the debate between Keynes and Friedrich Hayek ..

Keynes focused on the labor market, insufficient aggregate demand and the associated idea of less-than-full-employment income. In effect, Keynes thought of aggregate output as if it were just one undifferentiated thing and investment as a volatile form of spending that brought this output into existence.

Hayek focused on structure of capital. By this he meant the array of complementary (and substitutable) capital goods at different distances from consumable output. These capital goods work with labor and other factors to produce what Keynes would call “aggregate output.” Thus for Hayek “investment” wasn’t a homogeneous aggregate but represented specific changes to a structure of interrelated capital goods. When the central bank lowered interest rates excessively (below the rate that would equate planned savings with planned investment), the structure of production would be distorted. It is not just that “output” increased but its composition was altered.

This typically meant a number of unsustainable changes. Low interest rates discourage savings and yet at the same time encourage certain types of investment. Housing, commodities, and other sectors with long time-horizons would expand. But at the same time consumers would try to consume more. So the Keynesian is misled to think that, “See, consumption and investment are not alternatives. We can have more of both. In fact, consumption stimulates investment!”

What really occurs in the boom, however, is too much consumption and too much investment in sectors far from consumption. Overconsumption and malinvestment. Isn’t this what we have just seen?

.. [these are some of the reasons] we really should not ignore Hayek’s side of the academic controversies .. While the Treasury officials raised important points against Keynes they did not challenge him in the fundamental way that Hayek did. Today the issue is still Keynes versus Hayek.